Rise Of Alternative Video Platforms Adds To The Woes Of Time Warner Cable's Pay-TV Operations

Time Warner Cable and other cable operators have been losing pay-TV subscribers for many years. This can be attributed to various factors including market saturation and the delay in transition to a digital platform, which led cable customers to move to satellite and telcos. However, Comcast, the largest pay-TV operator in the U.S., has managed to turnaround its subscriber losses in the previous two quarters driven by its triple play bundling packages and its advanced platform of X1 and Xfinity Streampix. We believe that this turnaround will be shortlived as rise of alternative video platforms will weigh over the pay-TV operators in the long run (See – Comcast’s Pay-TV Subscriber Turnaround Will Be Shortlived).

Time Warner Cable currently has over 11 million subscribers and charges an estimated $66 monthly subscription fee, translating into annual revenues of over $9.3 billion. The estimated EBITDA margin of 37% for its pay-TV business translates into EBITDA of over $3 billion, representing 42% of Time Warner Cable’s overall EBITDA for 2013. We estimate a slight decline to the company’s current pay-TV market share of around 11.1% and any substantial gain is unlikely. The situation would be much different if the Comcast-Time Warner Cable merger is approved by the regulatory authorities. The combined entity will then command 30% market share in the U.S. pay-TV industry.

We estimate that the pay-TV operations contribute more than 40% to Time Warner Cable’s stock value. The cable company has been losing pay-TV subscribers for years now. The overall subscriber base has come down from 13.3 million in 2007 to 11.4 million in 2013, translating into 11.1% market share in the U.S. pay-TV industry. [1] This can be largely attributed to a combination of market saturation, fierce competition and the increased focus of providers on acquiring higher-value subscribers. Moreover, some consumers opt for a lower-cost mixture of over-the-air TV and other over-the-top viewing options.

We estimate the market share will decline slightly and be a little over 10.5% by the end of our forecast period. This will take the company’s subscriber base to around 11.5 million towards the end of our forecast period, reflecting a marginal increase from the current levels. This does not take into consideration Time Warner Cable’s merger with Comcast. If we consider the merger, the subscriber base will be around 30 million.

The reason we don’t expect a significant rise in subscriber base is the continued growth of alternative video platforms. Netflix in particular has been adding more and more subscribers every quarter (See Netflix Continues To Benefit From Content Superiority). As more and more people embrace lower cost options, including free programming and online video services such as Hulu, Netflix and Amazon Prime, pay-TV penetration may decrease over the years.

Time Warner Cable lost a whopping 825,000 pay-TV subscribers in 2013 alone. This can largely be attributed to the company’s dispute with CBS – Time Warner Cable blacked out CBS networks in many cities during the third quarter of 2013. It must be noted that CBS is the most watched network in the U.S. and telecasts some of the most popular shows such as The Big Bang Theory. Many customers who were unable to watch their favorite shows vented their frustration over the cable operator by cord-cutting/cord-switching. The company has frequently blacked out many networks in the past and paid the price by losing subscribers frequently. While Time Warner Cable’s arguments in such disputes are justified over the steep price increases by the content owners, the high demand for their programming puts the content owners at upper hand.

This leads to one of the key benefits of Time Warner Cable and Comcast merger. If the regulatory authorities approve the proposed merger, the combined entity will have close to 30 million subscribers in the U.S. and content owners wouldn’t want their programming blacked out to such a large audience as it will have a meaningful impact on their advertising income. Broadcasters such as CBS, NBC, FOX and ABC derive a significant portion of their revenues from advertising income. A large subscriber base will give Comcast much more muscle in negotiating the deals with the content owners.

Subscription Fee

While the company’s subscriber base has been declining, the average monthly subscription fees has been on an uptrend over the past few years. The ARPU has increased from $56 in 2007 to an estimated $66 in 2013. However, the growth in ARPU has been lower as compared to other pay-TV operators such as Comcast, which has seen ARPU growth of over 30% between 2007 and 2013.

Programming costs rise each year due to periodic increases in the carriage fee for various channels, which is a critical part of the multi-year agreements between media companies and pay-TV service providers. To protect margins the pay-TV companies typically increase prices periodically and thus subscribers bear the burden of increased programming costs. We expect this trend to continue and drive average subscriber fees up. We estimate that ARPU will continue to grow at the historical average growth rate of 3%, translating into ARPU of $82 by 2020. The growth in ARPU will drive the pay-TV revenues higher from $9.22 billion in 2013 to $11.2 billion towards the end of the decade.

It must be noted that there could be more than 15% upside to our price estimate if the company manages to raise the subscription prices at a higher pace and take ARPU north of $100 by the end of our forecast period. Similarly, there could be 10% downside to our price estimate if the company is unable to pass on the costs to customers and ARPU remains range bound around $70 levels towards the end of our forecast period.

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